Churchouse Letter
November 2012         by Peter Churchouse

Here We Go Again! Courtesy of the Fed and the ECB.

Unrestrained money printing in Europe and the US will see another round of liquidity entering Asian markets.

Inside This Issue:
The Fed and Mr. “we will do what it takes” Draghi have told us that the window of low interest rates is extended by another couple of years. This underpins positive trends for Asian hard assets, especially real estate.
Myanmar could emulate Thailand’s transition from military rule to a vibrant democratic economy.
The hottest IPO’s have a huge risk of underperforming once the first day of trading is out of the way. Lowly subscribed IPO’s have a high probability of outright gains and relative outperformance on a 12 month view.
Portwood Portfolio: cutting US high yield, US financials and EM Sovereigns, and buying more Gold.

The bi-polar nature of the global economy is once again making itself felt following a period of fixation on the Euro financial crisis and the US election circus. A year or so ago the focus in certain emerging markets, including Asia, was shifting back into a “growth fear” trajectory. The European financial and credit debacle, seemingly endless political jabbing and dearth of actual decision making encouraged emerging market investors to re-run their growth forecasts for Asian economies. Almost universally these were to the downside.

But the recent commitments by the Fed and the ECB to print money on an unrestrained basis encourages us to be even more favourably disposed towards Asian hard assets, particularly real estate. Asia will see at least some of that cash – it already is. The key risk for Asia is that this liquidity pushes asset prices too far, raising the prospects of further rounds of tightening initiatives aimed at curbing price appreciation in this sector.

Asia Asset Bubbles, Tightening, Slowing, Easing. The Cycle Has Gone Full Circle.

From fears of asset bubbles and anti inflationary policy settings in Asia that drove investment thinking from 2010 to the second half of 2011, the sentiment index swung to fears of slower earnings in the face of Europe in recession and a subpar, possibly recessionary US economic outcome.

By late 2011 markets began to toy with the ideas that Asian governments and central banks would likely ease policy settings and gently turn the liquidity taps on again in an effort to boost local economies at risk from tighter consumption belts in the west. To a very limited extent this did happen. China embarked on moves to ease the reserve ratio requirements, potentially freeing up as much as Rmb600 billion for lending into the economy. Banks in Chinarushed into the lending markets again in Q1 eager to place their new loan quotas for 2012. Around the region, lending pumps were switched on again, but much less aggressively than in 2009.

Quantitative Easing and LTRO Have Been Followed by Asset Price Inflation in Asia - Again. It is Hard to Conclude That There is no Cause and Effect.

Following a very sharp slowdown in credit extension in the second half of 2011, the easing of credit conditions provided an immediate boost to Asian economic prospects in the first part of this year. It is not a coincidence that this gentle surge in lending occurred in the immediate aftermath of two rounds of European Long Term Refinancing Operations (LTRO) in late December and January/ February that effectively aimed to achieve what earlier rounds of quantitative easing intended in the US. Cause and effect? Who really knows for sure.

This will further underpin hard asset prices in core Asian markets.

As for the earlier rounds of US Quantitative Easing, Asia looked set to become a recipient of at least some of this liquidity. Also as in earlier rounds of liquidity generation, European (and US) corporations and individuals still seem reluctant to take on new debt. Households in the west are busy deleveraging, and companies are generally cashed up but unwilling to place big bets on new investment in a climate of massive political squabbling and uncertainty. Why take the risk?

Deleveraging and dubious investment environment in Europe and the US will drive some of the “new” money to higher growth markets of Asia and elsewhere.

Some of this credit creation needs a home. Asian markets, not overburdened with debt, and boasting strongish economies can look like a relatively safe home for cash for banks with liquidity to spare.

Asian Asset Price Cooling Policies in 2011 Worked.

By the end of 2011 the various rounds of Asian policy initiatives aimed at slowing asset price inflation, particularly real estate, seemed to be working. China’s real estate markets had seen a growing number of cities reporting negative residential price movements on a monthly basis. The pace of sales of new homes fell sharply across the country and many developers resorted to often quite substantial price reductions for new launches of developments.

Rising asset prices are encouraging some governments to initiate cooling measures to restrain residential property price appreciation – Hong Kong and Singapore have adopted further tightening. China may also do more as property markets are recovering.

In Singapore sales volumes also fell and residential prices leveled out, with some modest downside.

Hong Kong, often the bell weather for real estate pricing volatility saw monthly residential transactions volumes halve and average prices fell by close to 10% in the second half of 2011 in response largely to government initiatives aimed at cooling the residential market.

Slower Growth Prospects Have Encouraged Modest Easing Again.

Risk in Asia is that asset markets may be too strong, not too weak.

The gentle easing of liquidity in the region since January/February has fed through into real estate markets. Yet again. For China sales volumes across the country as a whole in both secondary market and primary markets have picked up again, to levels not too far below levels of 2010’s bull market. Developers see much less need to discount prices. The posse of China property developers listed on Hong Kong’s stock market are broadly on track to meet sales targets set at the end of last year. And in the past couple of months, the numbers of cities reporting month-on-month declines in average residential prices has dropped back from earlier levels.

The more recent launch of QE3 in the US, and Mr Draghi’s “we will do what it takes” promises have provided further fuel to the recent recovery in real estate asset prices in key parts of the region that started earlier in the year.

China is Caught in a Cleft Stick. Rebalancing Needed.

It is under pressure to maintain growth in a world where its primary export markets are in recession or experiencing subpar growth. But at the same time it is under pressure to re-balance its economy away from exports and investment led growth more towards domestic consumption led growth model. Within this framework, housing construction qualifies as domestically led growth, and can be a major contributor to growth. It also meets a substantial need, and therefore sound social objectives.

China looks to rebalance its economy towards more domestic consumption. Construction and housing development help achieve that objective as well as fulfill a social need for housing.

But the rapid rises in prices in many markets across the country have stretched affordability and community patience. The general lack of investment vehicles in China and its closed capital account has meant that real estate is one of the few vehicles that investors have available to them. The large amounts of sold but unoccupied real estate stand as testament to this need for a wider range of avenues for investment. Certainly the stock market has been very much out of favour over the past couple of years, and this has fueled the flow of capital into real estate markets.

The Recent China Property Down Cycle is Flattening Out.

Given recent evidence of the China property markets perhaps bottoming out, and another round of global liquidity creation, we can probably expect China’s policy settings with respect to real estate to stand pat for the short term. There is precious little evidence of a return to a steady upside in residential prices on a widespread basis. But the price downtrend has probably ended, and sales volume downtrend has definitely ended, bringing with it the possibility of a resumption of upward pricing momentum.

This would not be welcomed by the politicos...

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